Southcross Energy Partners, L.P. (NYSE:SXE)
Q2 2014 Earnings Conference Call
August 06, 2014, 11:00 AM ET
David Biegler - Chairman & CEO
Michael Anderson - SVP & CFO
John Bonn - President & COO
Ethan Bellamy - Robert W. Baird
Selman Akyol - Stifel Nicolaus
Good morning, and welcome to the Southcross Energy Partners Second Quarter Financial and Operating Results Call. As a reminder, today's call is being recorded and your participation implies consent to such recording. At this time, all participants are in a listen-only mode. The question-and-answer session will follow the formal presentation.
With that, I will turn the call over to Mr. Michael Anderson, Senior Vice President and Chief Financial Officer. Thank you, sir. You may now begin.
Thank you, operator, and good morning, everyone. We appreciate you joining us for the Southcross second quarter 2014 financial and operating results call. With me today is David Biegler, our Chairman and Chief Executive Officer; and also John Bonn, our President and Chief Operating Officer.
Now before we begin, I would like to remind all participants that our comments today will include forward-looking statements. It should be noted that a variety of factors could cause the Partnership’s actual results to differ materially from the anticipated results or expectations expressed in these forward-looking statements. For a complete discussion of these risks, we encourage you to read the Partnership’s earning release and our documents on file with the SEC.
Today’s call will also contain certain non-GAAP financial measures. You can refer to the earnings release that we issued this morning for important disclosures regarding such measures, and you can obtain a copy of our earnings release in the Investor Relations tab of our website at southcrossenergy.com.
And with those opening remarks, I’d like to now hand the call over to David Biegler, our Chairman and Chief Executive Officer. David.
Thank you, Michael, and good morning to each of you. We appreciate your joining us for today’s quarterly call. I’m going to start with a brief review of the quarter, and Michael will be providing additional details in his presentation.
I will focus my remarks on the just completed combination with TexStar Midstream Services, and the significantly enhanced prospects for Southcross’ future performance.
We reported adjusted EBITDA of $10.2 million for the second quarter, which was below our guidance forecast. The primary reason that EBITDA fell short of our expectations was the effect of several plant upgrades and maintenance projects late in the quarter, which negatively impacted results by about $1.7 million.
We made the decision to proceed with this work in preparation for the volume growth we expect as a result of the TexStar transaction, as well as from newly contracted volumes that we have signed over the past few months. The plant upgrades are now complete and our assets are running well.
Our team has been extremely busy on the closing and integration planning for the Southcross TexStar combination. Further, our commercial teams have seen a sharp rise in new opportunities coming to us from producers interested in doing more business with our larger combined business.
Much of this is tremendous news and bodes well for the future, but our focus remains on running the day-to-day business and concluding contracts to fill our remaining processing capacity. We’re building a great organization that is doing just that.
It’s informative to point out that much of the financial impact of the plant upgrades and maintenance for this quarter would have been avoided had we already been part of the larger Southcross platform. This is because the combination of the two systems and associated interconnections will provide us with the ability to move volumes between our other facilities. This will be a welcome improvement as a result of the transaction.
The pipelines and processing plants at Southcross is acquiring are flowing volumes of approximately 100,000 MMBtus per day, and we expect that volume to double by this time next year. Supporting that growth are two minimum volume producer commitments totaling over 60 million cubic feet a day. Both are slated to be added to our system during the fourth quarter of this year.
Further, we continue to see strong producer activity on the Lancaster gathering system, which is owned by Southcross Holdings, and which now feeds into the Southcross pipeline and processing systems. The producers connecting to our system are not only some of the most active producers in the Eagle Ford, but also some of the most well capitalized.
We’re also on target for completing our Webb Pipeline during the fourth quarter, and adding a 35 million cubic foot a day minimum volume commitment from the anchor shipper on that line. So you can see we have just under 100 million cubic feet per day of volumes under commitment scheduled to come online in the fourth quarter.
These underpin our confidence in our fourth guidance. Combined with other volume additions our producers are forecasting along with several growth projects we are completing, give us the confidence that we are well positioned to deliver on our forecasted distribution growth starting with the first quarter of 2015.
The transaction with TexStar has enhanced who Southcross is and solidified where we’re going. I will provide an update on the financial and operational details of the combination, and then Michael will go into further details later in the call.
We closed the Holdings combination August 4, and as a part of the overall transaction, SXE, the Partnership, acquired all of the rich-gas system pipeline and processing assets of TexStar for $180 million in cash and 14.633 million of newly issued payment-in-kind Southcross convertible units.
There are four great things about the Partnership’s addition of the acquisition. First, it provides an immediate boost of EBITDA, which will significantly benefit our business. Second, the rich-gas assets are supported by the contracted volumes on the Lancaster system, which is a large gathering system and sour gas treating facility remaining at Southcross Holdings. We’re bullish on these volume additions because of its strong competitive position in sour gas treatment in a very active drilling area.
Third, having the new rich-gas assets means we’ve eliminated an estimated $50 million in capital expenditures that we are going to spend on the Webb Pipeline addition as we can now connect into the acquired pipeline and use it to bring our gas to our processing facilities.
And finally, we’re now well positioned to open up a much broader area for feeding rich gas into our plants. And it’s only been two days since we’ve closed, we’re excited and ready for this new stage for Southcross, and truly believe we have great assets and the best play in the country with a great team and strong backing to capture growth.
Our combination with TexStar brings scale, growth, operational and financial stability, and synergies to Southcross. In terms of scale, we’re now in the top five of Eagle Ford processors. Our scale is large enough to provide stability for customers, broaden up to provide any service that other midstream companies might offer, and yet nimble enough to provide creative solutions for customers, which can generate attractive growth rates for our investors.
We have four processing plants, two fractionation facilities, and approximately 3,000 miles of pipelines. Further, through our relationship with Southcross Holdings, we will have access to an extensive gathering system in the Eagle Ford region and connection to a new 63,000 barrel per day NGL fractionation facility near Corpus Christi that’s coming online in the next couple of months.
Our blended management team has enjoyed years of commercial success and has experience in building strong relationships that have added to the scale and will provide a strong foundation for the future. The producers we’ve worked with over the years like the combination, and are coming to us now with even larger opportunities. They like our new scale and the enhanced stability it provides.
In terms of this stability, and as mentioned earlier, we are in the process of interconnecting with the newly acquired assets. Not only will this create synergies and save us money, it also means our assets should run more smoothly as one platform and enable more predictable cash flow. This benefit cannot be overstated.
I know I don’t have to spell out the effect of interruptions in plant performance, even if it is planned such as in the last quarter. Having our combined assets interconnected significantly mitigates this risk. We’re also able to offer customers an enhanced wellhead to end-user platform with more assurance of market outlets for their production. We believe this integrated platform with access to the Corpus Christi market puts our company in a very advantageous competitive position.
Our growth prospects have also changed dramatically. We now have three distinct ways to grow. We have the ability to grow organically from a larger platform and have projects in progress. For instance, our Webb Pipeline is on time, on budget, and is now costing us about $50 million less due to this acquisition.
During the past few months, we signed three new commercial arrangements that should be generating cash flow at the beginning of the first quarter of 2015. These new contracts include adding approximately 10 million a day in enriched gas volumes with a growing producer in our territory, adding a 40 million a day lean gas sales contract in the Corpus Christi market, and building a pipeline connection in Mississippi that will enable us to add about 25 million a day in additional firm transportation volume.
Importantly, we have the ability to growth through expected drop-downs of assets held at Southcross Holdings, our parent level, including several Eagle Ford focused growth assets that would be beneficial to unitholders. Also, we continue to expect growth as we fill the already constructed capacities on the system.
Today, with the new assets as part of Southcross, we have an extensive pipeline network and four South Texas gas processing facilities with 685 million a day of total capacity. We’re currently just over 50% full, and the available capacity of about 300 million cubic feet a day provides us with great upside growth potential.
As previously mentioned, the already contracted volumes should increase processed volumes by about 100 million a day and raise us to about 70% of capacity by early next year, so we’re already well on our way towards filling capacity. The opportunities to create distribution growth for Southcross are now bigger and more visible than ever before.
I will spend a minute discussing the assets we now have at the Holdings level, which are outstanding assets in their own right and are expected to provide growth to Southcross through future drop-down transactions. The Holdings’ NGL system consists of the 63,000 barrel per day Robstown fractionation facility, and approximately 100 miles of pipeline to provide Y-grade to the facility and for purity product delivery.
This is a large fractionator constructed adjacent to its customer and proximate to the Corpus Christi market. The Robstown fractionator has been commissioned, is currently testing and is in start-up mode, and should be producing purity NGLs by the fourth quarter of this year.
The fractionator will handle virtually all Y-grade from Southcross’ Lone Star Plant, third-party Y-grade volumes for nearby processing plants, and potentially some Y-grade from our Woodsboro and Gregory processing facilities. The NGL system is expected to be ramping volumes over the course of 2015.
The Lancaster gathering system at Holdings is an extensive, more than 600 mile gathering system in Frio and La Salle Counties in the oil-producing window of the Eagle Ford. The gathering system has over 300,000 dedicated acres for more than a dozen producers, almost all of whom are increasing drilling activity and gas production.
The system has one sour gas treating unit in operation, one under construction slated for fourth quarter start-up and two more on order. The sour gas treating business is a terrific business with only a few competitors able to provide the full range of gathering, treating, processing and marketing capabilities that the combined Southcross and Holdings entities can provide.
We have the minimum volume commitment contract described earlier coming on during the fourth quarter, and expect to see continuation of producer drilling over the coming years. We expect continued growth of the system over the course of 2015.
We believe Southcross has great growth ahead in the very near future. By the end of this year, we’ll have a new major pipeline in place, a strategic combination integrated with significant asset drop-downs, and a broad portfolio of opportunities.
We’ll have a platform of assets across the Eagle Ford delivering to the large markets of Corpus Christi. We’re anxious to prove that we will execute on this tremendous growth opportunity.
With that, I’ll turn the call over to Michael to discuss the quarter, the transaction and our recent financial updates. Michael.
Okay. Thanks a lot, David. I will first review results for the quarter, and then I’ll turn to our financial outlook as a result of the TexStar combination transaction, and also, of course, the rich-gas acquisition.
As David mentioned, our second quarter adjusted EBITDA was $10.2 million. Our operational results were generally in line with the guidance that we had issued on July 10, with processed gas volumes up about 9% sequentially from the first quarter levels, and that was up to about 268,000 MMBtu per day, and largely a result of the additional processed gas volumes that came on to our system during the quarter.
For the quarter, our Woodsboro and Gregory facilities operated at about 60% of capacity, and NGL volumes rose about 14% sequentially over first quarter, and on a year-over-year basis, gas processing volume growth was a bit more substantial. Gas volume growth was up about 23% compared to the second quarter of 2013, and NGL sales volumes were up about 53% on a year-over-year basis.
During the second quarter, gross operating margin was $26.2 million. That compares to $27.2 million that we had in the first quarter, so we were down just a little bit. Some of the gross margin reduction was related to lower volumes in Mississippi and Alabama, part of which was related to an industrial customer whose plant was down for an extended time period.
Operating and maintenance expenses were $11.7 million in the quarter and G&A expenses were about $6.7 million.
As David mentioned, our EBITDA was negatively impacted by about $1.7 million related to the plant maintenance and upgrade activity. Additionally, we had the lower volumes in Alabama and Mississippi, and we also had slightly higher G&A and operating expenses than we had originally forecast.
Cash interest expense was $1.3 million for the quarter and maintenance CapEx was $1.4 million, so this left distributable cash flow of $7.5 million for the quarter, compared to cash distributions of $14.6 million.
As a reminder, on August 14, we will pay our second quarter 2014 distribution of $0.40 per unit to unitholders as of the record date of August 8, and these distributions will include the previous Series A convertible preferred unitholders that have now converted to common units as a result of the TexStar combination transaction.
During the first half of the year, capital expenditure spending was $54 million, with most of this related to the growth CapEx investment for the Webb Pipeline. Our capital spending expectations for the remainder of 2014 include about $30 million left to complete the Webb Pipeline, and also about $15 million of additional growth capital associated with recently added gas supply and also gas sales contracts. So for the full year, we expect CapEx to now be between $100 million and $120 million versus our prior guidance which was $125 million to $150 million.
At the end of the quarter, at June 30, our debt was $227 million.
David talked about the strategic benefits of the TexStar transaction, so I’ll talk a little bit about the finance side of the deal. As part of the overall transaction, Southcross acquired the rich-gas assets from TexStar for $180 million in cash and about 14.6 million newly issued PIK Class B Southcross convertible units.
These new PIK units carry a 7% payment on coupon based upon an issuance price of $18.61. They will be convertible to cash pay upon, among other conditions, a 10% increase in Southcross’ existing $0.40 per unit quarterly distribution payment and also our achieving at least a 1 times cash distribution coverage based upon a two-quarter look-back and a two-quarter look-forward basis.
Also, in conjunction with the transaction, we basically refinanced the entire debt structure at Southcross. We entered into a new seven-year $450 million term loan B facility, and also a five-year $200 million revolving credit facility.
The new term loan B carries pricing of LIBOR plus 4.25% with a 1% LIBOR floor. The revolver maintained its current leverage-based pricing grade of LIBOR plus a spread of 200 to 325 basis points. The revolver has initial pricing set at LIBOR plus the high end of that range or LIBOR plus 3.25%.
Leverage covenants at the MLP start out at 5.75 to 1.00 for third quarter and fourth quarter, and reduce gradually during 2015 to a steady-state leverage test of 5.0 to 1.0.
Now, we were very pleased with the reception that we received during the marketing of the debt facilities. We were significantly oversubscribed and we also reduced pricing on the facilities from the original price talk when we launched the financing.
We now believe we have flexibility to grow and the ability to manage our business well as we go forward. Remember also that Holdings, which owns about 57% of the limited partner units, including all of the subordinated units, will be forgoing unit distributions on our subordinated units until we have at least a 1 times distribution coverage at the MLP.
We do expect distributable cash flow will exceed cash distributions beginning with the first quarter of 2015. So, clearly we’re excited about Southcross’ acquisition of the rich-gas assets being acquired from TexStar. They have immediate synergistic benefits, including the CapEx reduction from the Webb Pipeline.
And with the completion of the Webb Pipeline project in Q4, Southcross is expected to have little additional required growth capital going forward, ample opportunity to grow cash flow through existing asset capacity, and expectations for growth of distributable cash flow.
We’re excited about our new Holdings and MLP structure with the potential for future drop-downs. We now have the opportunity to complete the mature assets before dropping them down to go further inside the MLP, and we believe that the Southcross Holdings’ current portfolio of asset drop-down potential is both attractive, as well as significant in terms of size.
As we mentioned before, the rich-gas assets that have been acquired at the SXE level represent only about one-third of the original TexStar assets. Two-thirds of those assets still remain at Southcross Holdings.
We’re also now much better positioned for potential growth projects with capital availability at both the Holdings and at the Southcross level. We expect to have flexibility to acquire or build a broader range of projects.
Now, with all this being said and with this growth that we’re looking at, we continue to expect to achieve our adjusted EBITDA guidance of $22 million to $28 million for the fourth quarter 2014, and that’s consistent with our press release that we had on July 10.
And while we are focused on achieving this guidance for the fourth quarter, we’re also looking to supplement future EBITDA generation from our expanded portfolio of assets. We see a lot of opportunities out there for ourselves right now.
So, from a financial standpoint, these past few months have clearly been momentous, we’ve raised new equity, secured a larger credit facility, completed a significant acquisition and also created additional financial flexibility for our company at our new Holdings entity.
We are committed to maintaining moderate leverage and believe that we are well positioned to act on drop-down and other opportunities to drive growth and value in the future. So there is clearly a lot to be excited about at Southcross.
And with that, I’ll hand the call back to David for some closing comments.
Thanks, Michael. The second quarter was truly a momentous one for Southcross, both strategically and financially. We completed the combination with TexStar Midstream Services and created Southcross Holdings, a leading Eagle Ford focused midstream provider.
We created the drop-down structure that will drive future growth and performance. We executed our first drop-down, expanding Southcross’ Eagle Ford assets with substantial new rich-gas pipeline capacity, an additional gas processing facility, and new residue gas pipelines.
We continued construction of our Webb Pipeline, which will open up new areas of the Eagle Ford for rich-gas volumes, and we completed a financing that will give us increasing capability to grow.
Once again, thanks for your interest in Southcross, and with that, I would like to open the line for questions. Operator, please open the lines.
Thank you. (Operator Instructions) Our first question comes from the line of Ethan Bellamy from Robert W. Baird.
Ethan Bellamy - Robert W. Baird
Obviously seen a lot of announcements about condensate activity in the Eagle Ford, is it as simple as that as positive in terms of price realizations and throughput for your systems or are there any other read-throughs to you guys?
This is David, I’ll take that one, Ethan, thanks for the question. I would say anything that enhances the takeaway out of the Eagle Ford is a benefit for us or is a positive, first. I would say the second is particularly if it’s take away directed toward what really is our competitive advantage, which is in and around Corpus Christi. We like the fact that we don’t have basis differential relative to the Houston Ship Channel to Mont Belvieu.
But importantly, we do have projects where we are attempting to determine our ability to take advantage of those opportunities to generate additional margins. We’re pursuing those, but I have nothing to talk about at the current time.
Ethan Bellamy - Robert W. Baird
Okay. And then, with respect to the drop-downs, can you give us some expectations about timing, value or multiples or anything like that?
Hey, Ethan, it’s Michael. I’ll give you a couple of comments. It’s mainly just a repeat of what we had before when we announced the deal, and we’re not going to get into specifics about when we think the timing is going to happen.
What we want to be able to do is drive strong distribution growth at SXE unitholders, and we think that the drop-downs are going to help us get there. We also think we’ve got a lot of terrific organic opportunities and ability to fill our capacity that will help drive that as well.
In terms of size, I think our best parameter is that, it’s just what we said before, which is the rich-gas system assets represent about a third of what was at TexStar, so we still have about two-thirds of that business upstairs.
You see how we’ve sized the parameter in terms of the valuation of rich-gas system and a consideration that was received there somewhere between $450 million and $500 million of value. So all that being said, we think there is significant value left upstairs for drop-downs that will help us drive distribution growth going forward.
Ethan Bellamy - Robert W. Baird
Last question. I'm sorry, did I cut you off there?
I just wanted to add, Ethan, because I do think it’s very relevant to kind of, let’s call it, our history, and we can go through the normal factors that everybody would employ in making that decision, it’s the consistency of distribution coverage et cetera.
The one thing I do want to add and make clear to everybody is very much on our mind is having those assets up and running and generating, let’s call it, stable and growing cash flows without, let’s call it, start-up uncertainty, and so I mean the Robstown fractionator is a good example. While we feel really good about what’s happening in the start-up, we want it up and operating on a consistent basis before that happens.
I just want to point out that we’re very aware of history, and we are very aware of the significance of doing that at that time and taking, let’s call it, the risk of start-up out of the equation.
Ethan Bellamy - Robert W. Baird
Got it, okay. Last question, if I remember correctly earnings is already getting to me unfortunately. I think Atlas said that they were looking for 2015 as really kind of a better balance in supply and demand for Eagle Ford gathering and processing. Is that consistent with your expectation about how the market is developing in the competitive landscape?
I’m going to let John answer that one, and then I’ll add to it at the end.
Well, we see – this is John Bonn. We’re seeing opportunities as other existing contracts will start rolling off in ’15 with existing supplies, but we’re also seeing increased activity and discussions since the announcement of this combination with not only our existing producers that want to expand our relationship, but new opportunities with producers in the Eagle Ford that quite frankly thought maybe we were too small before. So we see an increase of activity going through ’15 and ’16.
(Operator Instructions) Our next question comes from Selman Akyol from Stifel.
Selman Akyol - Stifel Nicolaus
So just to be clear here, in terms of your capital growth guidance of $120 million to $150 million coming to $100 million to $120 million, that’s really reflecting the Webb Pipeline reduced needs there?
That’s exactly right.
Selman Akyol - Stifel Nicolaus
Okay. And then, as we think about longer-term and you think about sort of growth capital going beyond 2014 into ‘15, should we think of that as coming down fairly significantly leaving the revolver available for doing drop-downs from that standpoint, or do you have a very strong backlog of organic growth projects and we would expect to see another meaningful build capital deployment coming off of the revolver?
Selman, I’ll take that, and then David can top-up as he sees fit. But I would say that right now what we have created is over the past four, five years, if you look at both the TexStar and the Southcross out of the business, we’ve had spent significant capital building the system that we’ve got today. And while we were running through pretty significant processed gas volumes, we’re still only in the order of 55% to 60% full.
So most of our focus right now is going to be on filling that capacity and we think we’ve got great opportunities. That being said, we’re still going to have some opportunities that we talked about today, which is in the order of spending $10 million and $15 million in terms of growth capital on nice projects, but nothing that would be real significant that we’re talking about today.
Now, I think, as John talked about a minute ago, what we’re seeing in terms of a different perhaps mindset with regard to customers in dealing with this and some new opportunities, we certainly hope that those are going to blossom into some perhaps bigger things, but right now they are not on our immediate portfolio of spending significant chunks of growth capital.
We’ve got a great opportunity to basically generate significant increases in EBITDA and distributable cash flow by filling our existing system. We think those other opportunities are going to come along, along with the drop-downs, but they are not in our near-term play right now, but we certainly think that over time we’re going to be – have the opportunity to do some of those.
The only thing I would add there. Michael has already covered it, but the only thing I would add, probably fairly obviously the bulk of the capital expenditure will be finance purchasing to drop-downs over the term.
The other is that on a play that’s still expanding, such as the Eagle Ford is and with additional demands from customers. What we wanted to have was the flexibility to be able to respond to the organic opportunities that are created. All you can model is generally what you know at the time, and my point is, for example, hypothetically, three months ago we would never have modeled any CapEx for condensate export, for example.
So the conditions changed, the markets changed, Corpus Christi export is changing quite a bit. It’s not just in the field area, the upstream side of the midstream business, but we’re very active delivering to end-use markets and to export. So, what we wanted to have was the flexibility to do that through the revolver, and we’ve created it and feel really good about it.
At this time, we have no further questions, I would like to turn the call back over to David Biegler for closing comments.
I want to thank you again for joining today for the call. Descriptions of a combination such as the one with TexStar are quite often clinical, but I don’t want to get lost in there, just the excitement that we have for this new phase of Southcross growth.
We’re excited about being associated with the team and TexStar and a number of great people there, and importantly the combination has already brought new opportunities, in fact, some that were discussed before we closed two days ago, and these are going to continue to accelerate into the future.
All of the things we talk about in terms of strategic advantage, we view as real, and we really look forward to updating you on the achievements that can result from that combination over the remainder of the year.
Thanks again for your time today, and look forward to our next visit.
Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.
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